Several European banks have put all work on the Fundamental Review of the Trading Book (FRTB) on hold amid a lack of clarity from the top.

The Fundamental Review of the Trading Book (FRTB), a key piece of post-crisis regulatory reform, is centred on minimum capital standards for market risk, and forces a rethink between firms’ trading and banking book.

The head of regulatory strategy for a major European bank told Practice Insight that although the EU is moving forward, implementation work on the ground has stalled because of the lack of certainty from the top.

“Implementing the FRTB is a massive task – because of the size and novelty of the approaches, but also because some of the calibrations and interpretations are still being renegotiated at Basel-level,” he said. “There’s still a lot of moving parts, with uncertainty surrounding the whole.”

There’s actually a multitude of reasons for this though: from regulatory uncertainty at Basel Committee-level to a practically unworkable Brexit timetable, banks have decided too much is unclear to progress.

The Committee is due to meet on December 12 to discuss the reforms, but last week the European Council called for a four-year delay for the eurozone after the US said it would need more time to review the rules. Banks have been saying for some time now that the framework, in particular how it relates to other pieces of prudential regulation, is excessively complex.

So far the EU is the only jurisdiction to have released a legislative proposal to implement the new rules, though the formal go-live is not scheduled until the end of 2019. But the Basel Committee is yet to agree on key points, such as how profit and losses (P&L) should be attributed at a trading desk level. That’s important, as a report prepared by the European Banking Authority for the Commission last year said that around 40% of desks would be likely to fail the P&L test.

KEY TAKEAWAYS

Several European banks have told Practice Insight they have put all work on the Fundamental Review of the Trading Book on hold, claiming there’s too much regulatory uncertainty;

The US has said it needs more time to review the framework, Australia, Hong Kong and Singapore have all announced delays, and last week the European Council called for a four-year delay to implementation;

London-based firms are also concerned about Brexit, in terms of both timing and what is required of them when the UK is outside the single market;

Market participants have called on the Basel Committee – which is due to meet next on December 12 – to admit that the existing timeline of implementation in 2019 is unworkable.

Another regulatory strategy head based in London said his bank is reluctant to start work on implementation in case significant amendments come from the regulator. “We can’t possibly start testing at the moment, because no one knows the parameters,” he said, adding that he expects the FRTB to be delayed until 2022 – if it survives at all. “There’s clearly no desire to implement something like this in the EU if the US isn’t on board too,” he added.

Speaking at an industry event in September Katherine Wolicki, head of regulatory strategy and liaison at HSBC explained just how unclear directions have been to this point. “I know we say there is a lack of clarity all the time, but really, what is required of us? What does an FRTB application look like? Do they want every bank to submit something different? I don’t think so,” she said.

"We can't possibly start testing at the moment because no one knows the parameters"

“I think regulators know that banks can’t start building their FRTB systems yet,” said Jouni Aaltonen, director in the Association for Financial Markets in Europe’s prudential regulation division. “That applies especially to large global firms, who need to know what’s expected of them in different regions. What would really be helpful is if the Basel Committee acknowledged that 2019 is obviously unworkable.”

The head of capital management at another global bank explained that approaches have varied significantly between firms – but most have not got beyond the point of defining desk structures.

Some went full speed ahead before the standards were even published; those have now scaled back this work. Others undertook prototyping work without fully integrating into their systems, while others still have looked to buy in standardised approach utilities, and may not have reconfigured their internal risk identification as inputs, he explained.

“That final group will have an uphill struggle to use internal models if they haven’t already thought through a good number of the moving parts,” he added.

A spokesperson for trade association UK Finance told Practice Insight that it fully supports the recommendation for a four-year phase-in period, starting with 60% of capital requirements in the first year. “It’s crucially important that the FRTB is implemented in a harmonised way across major jurisdictions – significant divergence will only lead to the fragmentation of liquidity pools,” he added.

Brexit adds an additional layer of complexity. Among the FRTB’s requirements is a 12-month back-testing period of all internal models before March 2019.

According to EY partner Henrik Axelsen, banks have to have all customers, products and services in the right place before they can begin running the internal model – otherwise it is physically impossible to do so.

“But I don’t know a single bank that has done that yet. Because of Brexit there is still so much discussion of locations,” he added. “It’s probably an impossible timeline, and there are not enough experts in the world to deal with it.”

Perhaps unsurprisingly, timing is not the only Brexit issue.

It’s also unclear whether banks can aggregate their trading desks across different jurisdictions, or if the regulator wants them to develop separate internal models for each European branch if the main operation is in the UK. If the latter and banks have to go with a standardised approach, they’d need to allocate far more capital to the EU entities than previously thought, explained Afme’s Aaltonen.

He is also concerned that regulators may want individual internal models, and individual risk management practices across different jurisdictions within the EU.

“Fragmenting risk management across jurisdictions is dangerous and inefficient, so that’s something banks are hoping will be reviewed at Basel level,” he said. “There are all kinds of risks associated with splitting up that risk management model.”

An EBA spokesperson said the authority will publish a discussion paper highlighting the implementation issues before the end of this year.

This article is published by IFLR Practice Insight, a new service launching soon. Practice Insight will analyse how financial institutions are reacting to new rules.